VNET Group Inc (VNET) 2013 Q4 法說會逐字稿

Good morning ladies and gentlemen. Thank you everyone and welcome to 21Vianet Group's fourth-quarter earnings conference call. (Operator Instructions).

Before we begin I will read the Safe Harbor statement. This call may contain forward-looking statements made pursuant to the Safe Harbor provisions for the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on management's current expectations and observations that involve known and unknown risks, uncertainties and other factors not under the Company's control which may cause actual results, performance or achievements of the Company to be materially different from the results, performance or expectations implied by these forward-looking statements.

All forward-looking statements are expressly qualified in their entirety by the cautionary statements, risk factors and details of the Company's filings with the SEC. 21Vianet undertakes no duty to revise or update any forward-looking statements for selected events or circumstances after the date of this conference call.

With us today is Mr. Shang Hsiao, Chief Financial Officer. Following management's prepared remarks, we will conduct the Q&A. At this time, I would now like to turn the conference call over to Mr. Shang Hsiao, 21Vianet's Chief Financial Officer for opening remarks.

Thank you operator. Good morning and good evening everyone and welcome to 21Vianet's fourth quarter earnings conference call. Today, because our President Frank is on the road, I will also read the opening remarks and strategic overview.

2013 was an important year for 21Vianet development as well as China's Internet infrastructure industry. Mobile Internet and cloud computing become increasingly pervasive both in China and globally and China communication infrastructure is spending greatly driven by the surging demand for data traffic, palpable government support and heavy investment by Chinese telecommunication company and Internet company. With this backdrop, we are seeing tremendous growth opportunity on the horizon. And we are committed to capture this emerging opportunity by implementing and executing upon our growth strategies.

Now let me take a minute to highlight the achievement and progress we have made in 2013 before walking you through our detailed financial results. Over the course of 2013 we made a great stride in expanding our capacity and market footprint as well as expanding our service by establishing new partnership and expanding upon other existing one with several world-class global corporation.

For our core IDC business, as we remain focused on growing our capacity to meet customer demand, we have at the same time tried to beef up our marketing efforts in strategic region markets and improve our overall utilization. We were very pleased that we maintained a utilization rate of 71.2% and achieved an EBITDA margin of 18.8% in the fourth quarter, while increasing our capacity in the second half of 2013. This strong performance was powered by the increasing customer demand for IDC business service and the expanded sale capability throughout China market.

For 2014 the core focus of our IDC strategy is to accelerate capacity build-out in our strongest market while continuing to improve market penetration in other regions. Overall we aim to deploy an additional 10,000 cabinets and achieve approximately 25,000 total cabinets by the end of 2014. In order to accomplish this goal, in December 2013 we entered into a partnership agreement with Huawei, a leading global ICT solution provider to work together in further developing China datacenter market.

By leveraging Huawei technical expertise, we will be able to speed up our IDC construction, reduce lead times and in turn significantly enhance our ability to keep up with fast-growing customer demand. With Huawei's vast experience in the China enterprise data market we are also very confident that our cooperation will support our marketing effort especially in the southern part of China. In addition to strengthening our leadership in the IDC market, we also expect this partnership will help us further optimize our cost strategy as both parties cooperate over issues related to engineering, R&D, sales, customer service and other elements of our business operation.

Now looking at our cloud business, we see the cloud business as a long-term engine of our growth as Chinese user and company are increasingly utilizing the software and application based in the cloud. In this regard we are very proud to have developed a key strategic partnership with two global leaders to accelerate the growth of our cloud business going forward.

First, let me give you a few recent update regarding to our Microsoft partnership. Since we become selected commercialization for the Azure and Office 365 in the late of the 2013, our cloud business revenue outperformed our initial expectation for the fourth quarter of 2013. Not only was we able to secure several thousand clients for our data platforms as of end of 2013, but we were also successfully in migrating a number of extremely large customer into the longer term contracts, putting us well on track to fully commercialize Microsoft Windows Azure by March and Office 365 in April of this year.

Following the launch of the public cloud service with Microsoft we developed another key partnership with IBM to bring their management private cloud to China, targeting larger enterprise in China with complicated IT infrastructure requirements. We aim to facilitate migration and management of this enterprise, mission-critical workload and application in the cloud. We, together with IBM, are firmly committed to commercially launch our private cloud service by mid-year of 2014.

Our cloud partnership with Microsoft and IBM not only will help us speed up our effort to develop a premier cloud ecosystem comprised of both public and private cloud service, but also will support customer expansion and diversification. Taken through 2014, we expect our cloud service partnership to become an increasingly important growth driver for our overall business. As such, we expect our cloud service partnership will generate approximately 10% of total revenue by the year end of 2014.

With the robust foundation we established in 2013 we are well-positioned as an integrated Internet service provider in China supported by multiple secular business drivers that will help power our growth going forward.

Now I will go through our financial detail. I would like to state that we will present non-GAAP measure on today's conference call. Our non-GAAP result excludes certain non-cash expenses which are not as part of our core business. The detail on these expenses may be found in the reconciliation table included in our earlier release. Also note that all the financial number we are presenting today are in RMB amounts unless otherwise noted.

Our net revenue for the fourth quarter of 2013 increased by 30.6% year over year to RMB545.9m. Net revenue from hosting and related service increased by 43.6% year over year to RMB364m primarily due to an increase in total cabinet under management as well as increased demand for the Company's CDN service. The MRR per cabinet was RMB10,694 in the fourth quarter of 2013 as compared to RMB10,520 in the third quarter of 2013. Net revenue from managed network service increased to RMB181.9m in the fourth quarter of 2013. This increase was primarily because of increasing network capacity demand for data transmission service.

For the fourth quarter of 2013 adjusted gross profit increased by 28.6% to RMB158.5m. Adjusted gross margin was 29% in the fourth quarter of 2013 compared with 29.5% in the prior year and 28.9% in the third quarter of 2013.

Adjusted operating expenses increased to RMB102m. As a percentage of the net revenue adjusted operating expenses was 18.7% compared with 18.5% in the prior year period and 17.8% in the third quarter of 2013.

More specifically, adjusted sales and marketing expenses increased to RMB41.7m from RMB28.5m in the prior-year period due to the expansion of our sale and service support team, and our marketing effort associated with the launch of Microsoft premier cloud service.

Adjusted general and administrative expenses increased to approximately RMB41.1m from RMB33m in the prior year period, primarily due to an increase in headcount, office rental and other expansion-related expense associated with our effort to expand this cloud computing service offering.

Adjusted research and development expenses increased to RMB19.2m from RMB19 -- from RMB16m, which reflects our effort to further strengthen its research and development capability and expand our cloud computing service offering.

The difference between adjusted operating expenses and our higher GAAP total operating expenses amount is primarily due to the change in the fair value of contingent purchase consideration payable, which was a loss of RMB7.2m, and share-based compensation expense of RMB22m. The change in the fair value of contingent purchase consideration payable results from an increase in the present value of estimate cash and share consideration at December 31, 2013 associated with our Company past acquisition.

From a profitability perspective, adjusted EBITDA for the fourth quarter of 2013 increased by 31.4% to RMB102.9m. Adjusted EBITDA margin for the quarter was 18.8% compared with 18.7% in the prior-year period and 18.6% in the third quarter of 2013. Our adjusted net profit for the quarter increased to RMB41m from RMB39.5m in the prior year period. Adjusted net profit margin was 7.5% compared with 9.5% in the prior year period and 5.7% in the third quarter of 2013. Adjusted diluted earning per share for the quarter was RMB0.10, which represents an equivalent of RMB0.60 or $0.10 per ADS.

As of December 31, 2013, our cash and cash equivalent and short-term investment was RMB2.6b, equivalent to $423m.

For the full year of 2013 our net revenue increased by 29% to RMB1.97b. Adjusted EBITDA increased by 24.3% to RMB365.6m. Our full-year 2013 adjusted net profit was RMB120.5m, with adjusted diluted per share of RMB0.31 which represents an equivalent of RMB1.86 per ADS.

Looking at our financial outlook, currently we expect first-quarter 2014 net revenue to be in the range of RMB575m to RMB590m. This represents a growth of approximately 33% in the comparable period in 2013. Adjusted EBITDA is expected to be in the range of RMB111m to RMB115m.

Beginning this quarter we will also provide full-year 2014 guidance. Net revenue for the full-year 2014 are expected to be in the range of RMB2.71b to RMB2.85b, representing approximately 40% growth over 2013. For the full-year 2014 adjusted EBITDA is expected to be in the range of RMB566m to RMB595m representing more than 55% growth over 2013. This forecast reflects the Company's current and preliminary view, which is subject to change.

This concludes our prepared remarks for today. Operator, we are now ready to take some questions.

(Operator Instructions). James Breen, William Blair.

Thanks for taking the question. Shang, I was wondering if you could just talk about the progression of the Microsoft contract and how do you think about that over the course of the next 12 months.

And also I think in the last quarter call you talked about some competition on the network side of the business. You know just are you seeing, just from a competitive standpoint, what are you seeing in terms of competition for both the network and the datacenter side? Thanks.

Okay. Thank you Jim. For the Microsoft actually we started the partial commercialization in late September of the last year. And during the last call I did mention about it. We expect Microsoft will generate $1m for 21Vianet in the fourth quarter of 2013. The number already come out. Actually the number significantly beat the $1m so we have a lot more than $1m revenue from the Microsoft in the 4Q.

And during the past couple of months Microsoft and our Company, actually we already signed a large, we call VIP customer, the customer who will contribute more than RMB100,000 per year to us. And the signing process is very encouraging. Like on a daily basis we are signing a lot of customers.

So I also described the total revenue from the Microsoft partnership for us in 2014. So like eariler I mentioned, right now the revenue we estimate should be somewhere around $40m. Right now the number should be on track based on the number of the customer we already have.

And I also mentioned about it, in March, actually this month Microsoft and 21Vianet jointly we will have an event to formally announce for the commercialization of the Window Azure in Shanghai. That will happen in this month. In the beginning of the April, which should also be very close from now, we will also announce Office 365 fully commercialization. So it's very exciting for us. So far it look like everything will be on track. So we will see. So that's for the Microsoft update.

And for the network side, if you guys can recall, during the last quarter call I did mention about the pricing competition from the network side because at that time China Telecom and Unicom did make an announcement they will reduce the bandwidth cost for the 30% during the next five years. So we did see impact. But come down to the November last year and everything becomes stabilized. Yes, the Company did reduce price also so that impacted the revenue but, however, the demand still remained quite good. So everything right now become stabilized. You can see from our number we still have the Q-by-Q growth and that's a little bit better than our original expected.

So things look like it's settled down. So for the 2014 we will continue to see the growth from the managed network service, probably between 10% to 15%. Okay, Jim?

Great. Thank you.

Thank you.

Chad Bartley, Pacific Crest.

Hi. Thanks very much for taking the questions. So in terms of your hosting revenue, if you exclude cloud which was better than expected and then you just indicated that network was better than expected, does that imply that the core hosting business is maybe a little weaker than you thought? So can you comment on that?

And then separately, in terms of self-built cabinet additions, that was lower than we had been forecasting. So what drove that and can you give us any help in terms of the expected additions in Q1 and maybe after that this year? Thank you.

Okay. Yes, thank you Chad. With additional revenue from the cloud business, if you exclude that, you will see our datacenter business, our core business, right now we forecast we are going to have a growth somewhere around 32%, 31% to 32%, if you exclude that. But overall the Company will have a growth of 40% in terms of the revenue.

Because according to the IDC report the datacenter business for the next five years should have a CAGR growth around 31% at this moment. We take a very conservative view for our hosting business because this is the first time the Company provides any revenue guidance to the street so we try to be conservative a little bit.

But the management remain strong confidence. We may have a better number for our hosting business. But if you look at the last year, 2013 over 2012, our hosting business actually increased by 40%. We have more than 40% growth. Hopefully we can replicate the last year performance. And, like I said, this is the first time we provide the annual guidance. We try to take a conservative approach on this one. So that's your first question.

And the second question regarding to the deployment of the datacenter, yes, we postponed some of the deployment from 2013 to 2014, particularly for some of the big datacenter, in order to maintain the utilization rate and stable gross margin etc. And we did mention earlier, this year we will deploy 10,000 cabinet. Actually that 10,000 cabinet come out from 13 different datacenter, but again two thirds of those cabinet will be deployed in the northern part of China where we have a very strong demand okay.

The purpose over here, I just want to ensure you, the demand remain very strong, okay. Anything we build in the northern part of China, actually even before we complete the deployment typically you will see 70% to 80% utilization rate already. That demand continue to be very, very strong. In the southern part datacenter at this moment typically will take us six months after deployment to reach, let's say, 60% to 70% utilization rate. So the northern path remains still a lot stronger than the southern path demand. That's still the trend.

That's still the trend so this year, if you -- I think you also have the Q-by-Q deployment of the cabinet. Again right now the current plan is you probably will see somewhere around 1,000 to 1,500 cabinet in Q1 and you go to then the 2,000 cabinet in Q2, and 3,000 in Q3, and another 3,000 probably in Q4. That's the current plan with the deployment schedule. Okay, Chad?

Okay. Thank you Shang.

Okay. Thank you Chad.

Lucy Liu, JPMorgan.

Hi. Good morning. Thank you for the call. I have three questions. One is on your utilization rate. I noticed that in fourth quarter you added 700 cabinets, but utilization rate seems like just a little bit down, 74% in third quarter to 71%. So I just wonder what's the reason behind that and also how should we read the utilization rate guidance for this year given quite much of the capacity you're going to add? So this is number one.

Number two, still wonder in terms of your agreement with Huawei, can you explain that further in terms of what kind of coverage, what kind of the business we can really benefit from this agreement? You said earlier that can help us to accelerate the construction and also shorten the supply. Just wonder how that's going to work.

And then lastly is in terms of the enterprise market. I remember from the previous conversation you mentioned that some initiative had been done there so wondering what's going on, how much of the additional revenue you can expect from enterprise market. Thank you.

Okay. Thank you Lucy. Utilization for the first quarter of 2013 was 71%, more than 71% utilization. The Company in the last day of the Q3, actually at September 30, the Company released a lot of cabinet, particular for the M6 datacenter. At that time I believe we released close to 900 cabinets. That's a release on the last day of Q3.

So in terms of the utilization, that impact at Q3 is not that big. But in Q4, that 900 cabinet actually will be 40 in terms of the weighted, when we calculate weighted utilization rate. But that 900 cabinet actually had been all sold down so you will -- they contribute some of the revenue in the Q4 and you will see they will contribute a lot of revenue in the Q1. So we use the weighted average to calculate utilization rate. That's why you see some of the decreased utilization rate over there but, in terms of the reality, we increase and saw more cabinet in the Q4.

In terms of the utilization rate guidance for the 2014, like I say, each quarter we will only deploy 1,000 to 2,000 cabinets. So the management goal is to maintain more than, in any cases, more than 70% of the utilization rate for the, through the full year of 2014. That's our goal.

Second question is regarding to the Huawei strategic partnership. As you guys are aware, typically will take the Company 16, let's say 12 to 18 months to complete datacenter completion. Huawei have a certain technology can helping the Company to deploy a datacenter, the time we only need probably 10 to 12 months. They plan to shorten six months of time of our datacenter construction through certain technology we call the module. In Chinese we call (spoken in foreign language). So that will totally accelerate the construction of the datacenter and that will save us a lot of cash flow. So that's main thing.

So right now we already have I believe assigned two datacenter to Huawei with the construction, two new datacenter. And Huawei will be the contractor to help us to build the datacenter within much shorter period of time. So that's a most important one for the strategic partnership.

We also talk about cooperation, including the Huawei server and everything, but at this moment our partnership with Microsoft we are using Dell server and for the IBM they are using their own server too without the involvement of the Huawei. So Huawei is right now more focused on Company core business, helping us to the datacenter construction. So that's a partnership that Huawei.

And so on this enterprise market, yes, we already initiate the enterprise market group. They are already started. Probably give us one more month, couple weeks later, the Company will announced to the street. This is very, very exciting because starting from the late of the 2012 and also for the year of 2013, in China we're starting to see a lot of financial institutions or even the big stay-home enterprise, they are willing to outsourcing their server to the third-party datacenter service provider like a 21Vianet. That never happened in China before.

If you guys can recall in the US, the enterprise market probably will generate a lot more revenue from the internet sector in the US. But in China at this moment two third of the Company revenue all from the internet sector. Only one third of the revenue is generated from the enterprise and before never have financial institution waiting to outsourcing. Right now, more and more. The Company signed actually several more banks. They are willing to outsourcing part of their server to the service provider like 21Vianet. So we expect the China enterprise market will starting to tickle up from this year and also going forward.

This is a huge market so the Company actually already put together an enterprise group leading team. And the leader, our general manager from this enterprise group, actually used to work for one of our US peers, their operation in China. They worked for Equinix. So the Equinix China have actually joined us to become the 21Vianet enterprise group general manager to help our enterprise group. So the new leader has excellent experience with his experience from the Equinix. So that's what we will do. They already have the business plan and we have put together a team under the new leadership for this new business opportunity and development. Thank you Lucy.

Thanks.

Colin McCallum, Credit Suisse.

Thanks very much for the opportunity. Shang, just a question on VAT reform in China. Supposed to go ahead in April I think. What impact will that have on you in terms of first of all, will you be expected to pay VAT? Will you have to pay more for bandwidth from China Telecom, Unicom? Will you be able to pass that on to your customers? How does that whole thing work for Vianet please? Thank you.

Thank you Colin. You asked very good question. This one is that is coming. And when we say VAT, it's we call value added tax. That's because for our business, normally before the VAT reform, actually even including currently we are paying the business tax. And the revenue we provided to the street, actually it's net sales; it's already after the business tax.

So the China is under reforming. Because our headquarters is located in Beijing and right now Beijing Tax Bureau still ask the Company to do the -- to pay the business tax and we are not sure when that will be changed. But the nationwide, based on the National Tax Bureau in China, they say they are going to ask all the companies to do that. But for 21Vianet, normally like value added tax or something like that, typically we will just pass through to our customer because this is the national policy.

And for the telecommunication industry actually we, before when we are paying the business tax, business tax average in China actually is around between 5% to 6% of the turnover. But for telecommunication industry it's only 3% because this is a restricted encouraging industry by the Chinese government so we're always paying 3% versus 5% for other industry.

So for the value added tax, what I mean is the company, the service provider need to pay the value added portion for the tax. But the normal value added tax in China is 17%. But for 21Vianet at this moment for the value added tax we only need to pay the 6%. But at this moment we really don't know when that will start.

But for us I don't think the tax impact will be that big compared to the industry because telecommunication industry for the value added tax will only need to pay 6% on the value added portion. So original business tax, we pay the whole thing for the 3%. So we are not sure whether or not would be a benefit to us or it's a loss to us, but in any given case those tax costs eventually will be included in the price that will pass through our customer. Thank you Colin.

Got it. Yes. Thank you very much.

Okay.

Kai Qian, CICC.

Thank you for taking my questions. The first question is about how is the operating cash flow for the last year 2013.

And my second question is about the pre-order or the demand side for the 2014. I know Shang just mentioned we will increase 10,000 cabinets in this year and I just want to know how is the pre-order and pre-sales.

And the next quick question is about the proceeds of the Dongguan. And the management mentioned that the Company are negotiating with MIIT for the C2C license maybe in Dongguan as a pillar city. So how is going on and any expectations from this?

And then the last two questions is how -- about the EBITDA, adjusted EBITDA margin and for the 2014 how we aim to focus on this adjusted EBITDA margin. Thank you very much.

Okay. Thank you Kai. On the CapEx spending for the 2013, we spend around RMB550m. Original we guide to street that will be around RMB600m, but we only spend RMB550m because maybe we can raise some of the cabinet to be deployed from 2013 to 2014. That's your first question.

Second question regarding to the pre-order for the 10,000 cabinet, because some of the cabinet will be deployed in the second half, but I can give you some pre-order. Some of them they are not legal binding. This just an indication. Depend on the subject to inspection of the new datacenter. But at this moment we already have more than 2,500 cabinets have been reserved by many Internet company and also the enterprise, and also our cloud partner including from the Microsoft and IBM. So that one already more than 2,500 cabinets we can see.

But the total amount will be deployed will be 10,000 cabinets so we do expect this number will continue to go up, pre-order one, quarter-by-quarter. So that's number two.

Number three is Dongguan JV. Yes, as you are aware, the Company set Dongguan joint venture and joint venture actually already started operation. One of the major tax for the Dongguan joint venture is to capture the opportunity which stayed by the central government, which there is official policy come out from the central government of China last year. One of the most important policies for us is the central government actually like to encourage the domestic company to invest in the basic telecommunication industry in China.

That's a great signal. What I mean is China central government tried to breakout certain monopoly of the telecommunication industry in China. As you guys can recall, China, when we say fixed line broadband provider, actually its China telecomm and Unicom.

So the joint venture set up is with Dongguan government. And Dongguan government actually right now is negotiating and also we are putting the report, application to the central government, try to get certain license. I am not going to say it's a basic license. Maybe similar to basic license for broadband license application. 21Vianet, we do have the interest to get a basic license or get a broadband license. Not to expending a lot of money to do the voice; that's not the thing we will touch. But to engage in broadband business, that's very critical for the Company for the next couple of years.

And you guys can recall the biggest, the Company cost of sale actually is the purchased bandwidth from the China Telecom, Unicom. Each year the Company will expend somewhere around RMB500m to RMB600m to purchase the bandwidth because we cannot -- when we purchase bandwidth, we purchase 100%. I'll just let everybody on the call know. In US peering-to-peering, everybody can do that, but in China right now the traffic's still under [train set]. But if you can get a broadband license, let's say a basic license, typically you can starting to do the peering-to-peering. That's first thing.

Then actually we got a lot of the customer in our datacenter, we generate traffic, but we still need to purchase the bandwidth 100% from China Telecom and Unicom because we don't have the basic related license. So we cannot sign the reciprocal agreement with the China Telecom and Unicom.

But if one day Chinese government, they allow us to engage in basic telecommunication industry, without spend any money, just give us legal capability, then we may sign a reciprocal agreement with the China Telecom, Unicom to exchange the traffic. And by doing that our bandwidth purchase from China Telecom, Unicom will be significantly reduced, even more than 50% based on the current traffic generated from our datacenter, a lot of traffic.

So we will see this is a very encouraging policy to a domestic company like a 21Vianet. And you guys also understand our peers, datacenter service provider from the US, one of their most profitable business we call cross-connect. The margin could be more than 90% cross-connect.

What I mean is very simple. If you have got datacenter customer in your datacenters, they want to exchange, do the transmission of their data and content directly, then all you need to do, just connect the fiber or to connect the cable and you can ask them -- and you can connect the feed, transmission feed from both of the company, saves the bandwidth. But in China that's still not allowed because all the traffic need to be restricted, as the [train set].

But if we can get the basic license then the 21Vianet, we can legally operate the cross-connect. That will significantly generate, increase the Company profitability, also increase the revenue. That's all potential. That could happen in any price because China want to open the telecommunication industry.

So the Dongguan JV, 21Vianet hold 90% with the 10% from the Dongguan, and behind that is Dongguan province, the biggest telecommunication consumption province together with putting the application and report to the central government. So that one is in the process. So that will be -- if we can get certain licenses like that, that will totally change the company profitability and financial model. So that's very encouraging. So we are still waiting and we expect it may be during the middle of this year maybe we can see the first indication from the ministry, from central government to see how we're going to perceive that. Again it's no guarantee, but we just follow central government policy.

And your last question -- sorry, I spent a lot of time over there just to keep everybody updated on this important issue.

And the last one is EBITDA margin for the 2014. Because, as you guys are aware, our EBITDA margin, adjusted EBITDA margin in the whole year of 2013 was 18.8% or 19% is like that, due to the cloud because we already commercialized Microsoft cloud, IBM cloud. And those service we only recognize the net revenue so the EBITDA margin actually are a lot higher than our core business.

So we do expect in the 2014 our EBITDA margin you probably will have a 2% increase for the overall Company. Not just to the end of the 2014; I am talking about average for the whole year. So we should increase 2% so from 18.9% to 20.9%. That will be our EBITDA margin forecast for the whole year of 2014. So profitability should increase. That's a very, very good sign. Okay. Thank you Kai.

Thank you. Thank you very much.

(Operator Instructions). We have no further questions on the line today. I will now hand the call back to Mr. Shang for closing remarks.

Okay. Thank you everyone to share our remark for 2013 and the outlook for 2014. 2014 should be very a exciting year for the 21Vianet. So thank you so much for your time today. Thank you. Bye-bye.

Ladies and gentlemen, that does conclude the call for today. Thank you all for your participation. You may now disconnect.